Non-Paper on the Clean Development Mechanism

(Australia, Canada, Iceland, Japan, New Zealand, Norway, the Russian Federation, Ukraine and the United States)

1. Purpose

1. This submission sets out some preliminary views of Australia, Canada, Iceland, Japan, New Zealand, Norway, the Russian Federation, Ukraine and the United States on the modalities and procedures for the Clean Development Mechanism (CDM), as requested in Decision 7/CP.4. It is intended to facilitate the important global dialogue on the priority development of the CDM. This dialogue will require the active involvement of all Parties. The submission is also intended to enable Parties to take a decision on the Kyoto mechanisms at the sixth session of the Conference of the Parties. This paper will address only those issues directly related to the design and operation of the CDM.

2. Introduction

2. Article 12 of the Kyoto Protocol defines the Clean Development Mechanism, outlining its basic structure and the functions it is to perform.

3. The CDM offers Parties opportunities for cooperation on technology, capacity building and financing. It also offers Parties the opportunity to accrue certified emissions reductions from projects that reduce or remove greenhouse gas emissions beginning in the year 2000. With the year 2000 approaching, it is important that progress be made expeditiously.

3. What is the CDM?

4. The primary objectives of the CDM are to: assist Parties not included in Annex I in achieving sustainable development and in contributing to the ultimate objective of the Convention, and to assist Parties included in Annex I in achieving compliance with their quantified emission limitation and reduction commitments under Article 3 (Article 12.2).

5. The CDM is a market-driven concept that will rely heavily on private sector participation, although Article12.9 also allows participation by public entities.

6. In order to meet the objectives in Article 12.2, the CDM will need to be environmentally sound and economically efficient. This will also be important to attract investors. In addition, the mechanism will need to be designed so that participation in CDM project activities is voluntary; non-Annex I Parties benefit from project activities (i.e., enhanced access to new technologies, increased investment and financing, increased institutional and technological capacity and improvements in other environmental areas); and any institutional arrangement related to the operation of the CDM is efficient and minimizes costs while ensuring transparency and accountability.

4. CDM FRAMEWORK

7. The CDM should be established on a timely basis, and structured to ensure that project activities provide real, measurable and long-term benefits related to the mitigation of climate change while minimizing transaction costs. The CDM should also ensure capacity building and access to information by all interested Parties.

4.1 Scope of Projects

8. Project activities under the CDM should be comprehensive (include all project types, including reductions and removals and cover all six gases), unless a project is shown to be ineligible. Emission reductions or removals from project activities, including Activities Implemented Jointly (AIJ) projects, begun before the CDM is operational could be retroactively certified from the year 2000 onward, provided that the project and resulting reductions or removals meet the applicable CDM criteria and were approved by the participating Parties on the understanding that it would be developed as a CDM-type project. Further work on eligibility criteria is needed.

4.2 Project Participation

9. Participation in CDM project activities should be open to any private and/or public sector entity in a country wishing to participate. Guidance for participation should be provided, as necessary, by the Party within which the entity resides.

4.3 Project Development and Financing

10. There are several ways in which projects could be developed and financed. Projects could be undertaken provided that the Party(s) and/or their legal entity(s) have met all applicable criteria and that certified emissions reductions from all CDM activities are subject to the share of proceeds per Article 12.8 (see Section 8). Certified emission reductions would be apportioned among project participants according to terms of contractual agreements. Projects could be financed through private and/or public sector investment and financing, or if necessary by grouping small projects together to create an investment portfolio. These portfolios could be managed by private sector institutions with the appropriate expertise. In order to ensure a robust system with the broadest participation possible, these and other options should be considered.

5.CDM PROCESS

11. For the purposes of this paper, certification is defined as a two-step process whereby: 1. projects are registered with an operational entity prior to implementation, and 2. once project activities are underway, the resulting emissions reductions or removals are certified on a periodic basis.

5.1 Project Registration

12. The design of the CDM should incorporate a project registration phase. Projects would be registered with an authorized operational entity (see paragraphs 29-32) to confirm that the project meets sustainable development goals of the host country, is voluntary, provides real, measurable and long-term benefits related to the mitigation of climate change, and that the reductions in emissions are additional to any that would occur in the absence of the certified project activity. Project registration would establish the basis for ex-post calculation of credits. Actual emissions reductions would be certified by the operational entity only after they occur. This registration step would remove much of the uncertainty related to project development.

13. In addition to the criteria listed in Article 12.5, projects would need to meet the approval criteria of each Party involved, particularly the sustainable development requirements of the host country. A Party hosting a CDM project will need to consider the relationship of the project to achieving its sustainable development objectives. A host countryf s decision to approve a project should constitute a determination that the project is consistent with its sustainable development objectives.

14. The process by which projects are approved will differ from country to country. The system should allow countries to develop their own internal mechanisms for project approval based on their domestic priorities. Some Parties may choose to institute offices similar to those under the AIJ pilot phase whose functions could include, among others, reviewing and approving project proposals. Points of contact of agencies responsible for CDM activities within a Party (for project approval, for instance) would be of great help to entities involved in a project.

5. 2 Baselines

15. Methodologies for calculating emissions reductions or removals will be critical to the success of the CDM. For projects to be registered under the CDM, baselines will need to be established. Baseline methodologies will need to provide a basis for ensuring that the resulting reductions or removals are real, measurable, and have long-term mitigation and/or sequestration benefits that would not have occurred in the absence of the certified project activity.

16. To date, baseline discussions have focused on two approaches: project-by-project and standardized baselines. Work on baselines is currently being done in several fora that may be useful when designing methodologies for the CDM. Experience gained from the AIJ pilot phase on baselines will also be helpful.

17. How additionality is assessed will depend on which methodologies a project developer uses. Under a project-by-project approach, developers would have to establish a base case against which the projectf s emissions will be compared. If the projectf s emissions are below the base case, then it would be considered additional. Standardized baselines for a type of project, for example benchmarking, could be developed to distinguish between those activities that generate greenhouse gas reductions in excess of the baseline and those that do not. Activities that perform better than the benchmark would automatically be considered additional. Transaction costs and reporting requirements are likely to vary by the approach taken.

5.3 Project Monitoring

18. Project participants would be required to monitor project emissions. As part of the registration process, operational entities will need to ensure that project proposals contain adequate provisions for monitoring. The data collected would be used by operational entities for certification purposes.

5.4 Certified Emission Reductions (Certification and Issuance)

19. Operational entities would certify emissions reductions periodically, possibly on a yearly basis, after the reductions or removals have actually occurred. Article 12 is unclear, however, as to how the Certified Emission Reductions (CERs) should be issued. Since the operational entities certify the emissions reductions after they have occurred, it would be advantageous to have them issue the CERs. In this case, the CER could include a designation as to who had issued it. Guidelines and procedures will also be needed for consistent, uniform reporting by operational entities to the Executive Board.

20. Certified Emission Reductions (CERs) should be issued in standardized units of one metric tonne of carbon dioxide equivalent (calculated using the global warming potentials defined by Decision 2/CP.3 or as subsequently revised in accordance with Article 5 of the Protocol). To simplify tracking of the CERs they should be serialized. This number could include information on the host country, the project, the year of issuance and the certifier.

5.5 Project Auditing /Verification

21. Article 12.7 calls for independent auditing and verification of project activities. When designing modalities for auditing/verification, it will be important to bear in mind that the frequency of audits will have a direct impact on the cost effectiveness of the CDM. It is also not clear that all projects need to be continuously audited in order to ensure the environmental objectives of the CDM. Clear definitions and requirements need to be identified to define the scope, intensity and frequency of auditing/verification. Possible options could include auditing on a periodic or random basis.

5.6 Reporting by Parties

22. Article 12 does not specifically address reporting on project activities or on the resulting CERs. In order to ensure accountability and transparency, reporting guidelines on CDM activities will need to be established for Annex I and non-Annex I Parties. Project activities under Article 12 could be reported on by Parties annually. In addition, a form of reporting on project activities could occur through the national communications process for which guidelines might be needed. Annex I Parties will also need to report on CERs resulting from CDM project activities used to meet their Article 3 commitments, pursuant to Article 7 of the Protocol.

6. Institutional Arrangements

23. The basic roles and functions of the CDM are articulated in Article 12. The main bodies include the Conference of the Parties serving as the meeting of the Parties to the Kyoto Protocol (COP/MOP), the Executive Board, and operational entities.

24. The structure of the various institutions within the CDM will be critical to the operation of the CDM. It is important to note, however, that the structure of these institutions may be guided in part by the functions of the CDM.

6.1 COP/MOP

25. As stated in Article 12.4, the CDM is subject to the authority and guidance of the COP/MOP. This guidance should include: modalities and procedures governing the operation of the CDM; providing guidance to the Executive Board; and periodically reviewing operations of the Executive Board, operational entities, and independent auditing.

6.2 Executive Board

26. The Executive Board would supervise the CDM, and could provide guidance on operational and technical issues. Although Article 12.5 states that operational entities will be designated by the COP/MOP, the Executive Board would accredit operational entities based on guidance from the COP/MOP. The Executive Board would review reports submitted by operational entities and provide synthesis reports to the COP/MOP. In some cases, the Executive Board may need to draw on experts to develop technical guidance. The Executive Board would function as a separate standing body of the COP/MOP and report to the COP/MOP through the Subsidiary Body for Implementation.

27. The Executive Board should be relatively small and composed of an equal number of Annex I and non-Annex I Parties. A possible model for the Executive Board of the CDM might be the Executive Committee of the Secretariat of the Multilateral Fund for the Implementation of the Montreal Protocol. In this case, the Executive Board would be comprised of seven members each from Annex I and non-Annex I Parties, each serving two-year terms with the ability to serve consecutive terms. The chair and the vice-chair of the Board would alternate each year between the two groups. Nominations of Annex I members would be limited to Annex I Parties; nominations of non-Annex I members would be limited to non-Annex I Parties.

28. The UNFCCC Secretariat could provide administrative assistance for the CDM. Some of the activities could include compiling and synthesizing information related to CDM activities from the operational entities and/or Parties and other duties.

6.3 Operational Entities

29. In order to ensure cost-effectiveness and efficiency, the operational entities could be drawn from private sector institutions (e.g., international accounting firms/certification bodies). It would be valuable to have multiple operational entities, as each may develop expertise in individual regions or types of projects, thereby engendering greater confidence in their results. These entities should be independent and decentralized, but required to use any guidelines established by the COP/MOP or Executive Board. Operational entities who fail to abide by CDM and/or Executive Board guidelines should lose their accreditation.

30. Practical functions of the operational entities would include reviewing projects based on guidelines and criteria adopted by the COP/MOP, and registering them as CDM projects. Once a project has begun, the operational entity would certify a projectf s emissions reductions or removals after they have occurred. Operational entities could also issue CERs. Operational entities should also submit activity reports to the Executive Board.

31. Operational entities should be accredited by the Executive Board based on guidance from the COP/MOP. The operational entities would be subject to all rules and guidelines governing the operation of the CDM. A list of operational entities would be maintained by the Executive Board and made publicly available.

32.To avoid conflicts of interest, operational entities that register and/or certify project activities should not be involved in project development, promotion, financing or implementation.

6.4 Independent Auditing

33. Article 12.7 states that the COP/MOP shall elaborate modalities and procedures with the objective of ensuring transparency, efficiency and accountability through independent auditing and verification of project activities. Independent auditing will play a critical role in ensuring the environmental credibility of the mechanism.

7. CAPACITY BUILDING

34. Capacity building is a crucial element to the success of the CDM. Information on a variety of topics will need to be made available to interested participants. One way in which this could be achieved is through an electronic clearinghouse (a web-site) that will provide access to general information and technical assistance. The clearinghouse could provide information exchange services, links to other sites (e.g., technology related sites such as Climate Technology Initiative or national web sites on domestic criteria), participant and project eligibility criteria, CDM rules and procedures, and project opportunities around the world. Information, such as a list of operational entities, any reports submitted to and approved by the COP/mop, etc. could also be housed here. Other types of information services that could be provided include technical assistance on issues like baselines and monitoring, contracts, points of contact within participating Parties, etc.

35. Developing countries can influence the distribution of CDM project activities by promoting an enabling environment that will encourage the development of CDM projects within their borders. Parties could also work to improve capacity for undertaking project activities. These types of capacity building activities can promote broad participation in the CDM without the introduction of market-restricting rules.

36. Provisions as necessary to assist in arranging funding of certified project activities could be achieved through the following: listing project opportunities around the world, providing information on financial resources, matching projects with potential investors or providing information on the various ways to develop and finance projects.

8. Share of Proceeds

37. Article 12.8 states that the COP/MOP shall ensure that a share of the proceeds from certified project activities will be used to cover administrative expenses and to assist particularly vulnerable developing countries to meet the costs of adaptation. In order to achieve this, the share of the proceeds should be calculated as a percentage of the CERs generated by a particular project in a given year. This should be restricted to a limited percentage to ensure that the CDM remains a cost-effective vehicle for investment. Keeping the administrative costs to a minimum would allow the majority of the share of proceeds to go toward assisting developing country Parties particularly vulnerable to the adverse effects of climate change.

9. Further Work

38. The Subsidiary Body for Scientific and Technological Advice and the Subsidiary Body for Implementation should take up the issues raised in this paper on a priority basis. Categories of issues to be taken up for further elaboration include:

ECriteria for participation

ECriteria for accreditation of operational entities and entities for independent auditing

EProject eligibility criteria

EMethodologies for calculating emissions reductions or removals, including for establishing benchmarks and project-specific baselines

EGuidelines and procedures for registration, certification, auditing/verification and reporting

ESystems for recording and tracking serialized CERs once they have been issued

EInstitutional roles

ECompliance

ECriteria/guidelines for share of proceeds to assist developing country Parties that are particularly vulnerable to the adverse effects of climate change to meet the cost of adaptation

ELinkages between the CDM and other mechanisms.